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    Credit Operations

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    Grace Opekete
    This document proposes a research project on the credit operations of Nigeria's financial sector and the challenges they pose. It notes that credit is the largest risk factor for most financial institutions. Key challenges facing the sector include high levels of non-performing loans, increasing interest rates, high operating expenses, and corporate governance problems. The research will examine these issues over 5 chapters and make recommendations to address the non-performing loan problem through developing an NPL market and regulatory efforts to ensure banks rid themselves of bad loans.

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    Credit Operations

    Uploaded by

    Grace Opekete
    757 views4 pages
    This document proposes a research project on the credit operations of Nigeria's financial sector and the challenges they pose. It notes that credit is the largest risk factor for most financial institutions. Key challenges facing the sector include high levels of non-performing loans, increasing interest rates, high operating expenses, and corporate governance problems. The research will examine these issues over 5 chapters and make recommendations to address the non-performing loan problem through developing an NPL market and regulatory efforts to ensure banks rid themselves of bad loans.

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    CREDIT OPERATIONS

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    This document proposes a research project on the credit operations of Nigeria's financial sector and the challenges they pose. It notes that credit is the largest risk factor for most financial institutions. Key challenges facing the sector include high levels of non-performing loans, increasing interest rates, high operating expenses, and corporate governance problems. The research will examine these issues over 5 chapters and make recommendations to address the non-performing loan problem through developing an NPL market and regulatory efforts to ensure banks rid themselves of bad loans.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as DOC, PDF, TXT or read online from Scribd
    Download as doc, pdf, or txt
    757 views4 pages

    Credit Operations

    Uploaded by

    Grace Opekete
    This document proposes a research project on the credit operations of Nigeria's financial sector and the challenges they pose. It notes that credit is the largest risk factor for most financial institutions. Key challenges facing the sector include high levels of non-performing loans, increasing interest rates, high operating expenses, and corporate governance problems. The research will examine these issues over 5 chapters and make recommendations to address the non-performing loan problem through developing an NPL market and regulatory efforts to ensure banks rid themselves of bad loans.

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    of 4

    A PROJECT PROPOSAL ON CREDIT OPERATIONS: ITS PROBLEMS

    AND CHALLENGES FOR THE NIGERIAN FINANCIAL SECTOR

    INTRODUCTION
    This research aims to analyze the effect of granting Credit facilities
    operations of financial institutions to sectors of the economy and the inherent
    threat it poses to these financial institutions. The financial sector plays a significant
    role in mobilizing funds to fuel investment and growth. The effectiveness and
    efficiency in performing its role, particularly intermediation between the surplus
    and deficit units of the economy, depends largely on the level of development of
    the financial system. The more developed and stable financial sectors tend to be
    associated with the mature economies while the under-developed financial systems
    feature in developing countries. As a process the financial system adjusts to
    changes in the real economy just as the economy responds to developments in the
    financial sector.
    This role is particularly significant in Nigeria where Banks continue to
    dominate the Financial markets, other units in the Financial sector/lending system
    include the CBN, NDIC, Securities and exchange commission (SEC),National
    insurance commission (NAICOM), National pension commission (PENCOM),
    Deposit money banks, Discount houses(DH), Microfinance banks, Primary
    Mortgage Institutions (PMIs), Development banks, other lenders- leasing
    companies, and the informal sector (CBN Annual Report, 2008). In 2004, the
    banks accounted for about 80% of the total resources of the financial system.
    Expansionary economic activities by corporations and the government are mostly
    financed by the banking sector. The domestic-owned banking sector constitutes the
    largest component of the financial sector and lends primarily to the oil and gas
    (25.5% of total credit to the private sector in 2008), and telecoms sectors (16.7%).
    Bank credit remains the main source of external formal financing for Nigeria as
    development of corporate debt and equity market are still in its early stages.
    According to Onyeagocha (2001) the term “Credit” is used specifically to refer to
    the faith placed by a creditor (lender) in a debtor (borrower) by extending a loan
    usually in the form of money, goods or securities to the debtor. Credit is the largest
    element of risk in the books of most financial institutions as well as failures in the
    management of credit risk, by weakening individual institutions and in some cases,
    the lending system as a whole which have contributed to episodes of financial
    instability. Empirical studies on challenges faced by the financial sector have
    shown that poor assets quality (predominantly credit loans) has been the most
    frequent factor in Bank failure. Stuart (2005) emphasized that the spate of Non-
    performing loans (NPL) is as high as 35%. This implies the reason for distresses
    and crises in the financial sector as the interest charged on these loans and
    advances constitute the major source of income to these lending institutions.
    However the giant steps taken since 1958 and especially the said innovations of the
    CBN in 1986 has not been able to provide enough backbone for the financial
    industry as reflected by the down turn in the events of late 1980s which were
    characterized by the unprecedented level of distress as reflected in large volume of
    non-performing loans, insolvency, liquidity problem and default in meeting
    depositors and inter-bank obligations. This poor state of the banking system was
    exposed in 1989 with the government directive to withdraw the deposits of
    governments and other public sector institutions from banks to CBN. Thus, the
    number of distressed banks increased at an increasing rate from 7 in 1989 to 60 in
    1995 and decreased to 7 in 2000 while the banking system non performing loan
    started with N2.9billion in 1989 and peaked at N44.5 billion in 1995, came down
    to N17.3 billion in 2000 but picked up from 19.23 in 2001 to N49.60 billion in
    2004. (Okpara, 2009). In light of this, where the sizeable part of the finance sector
    earnings is cut off, it creates friction in the performance of its operations, that is, it
    poses a threat to the profitability of the sector and thus its performance. Umoh
    1994, traced the rising problem of banks to challenges from its credit operations
    i.e. poor loans processing, undue interference in loan granting process, inadequate
    or absence of loans collateral, among other things.

    Challenges of Credit Operations in the Financial sector


    According to Obalemo (2004) credit risk is an assumed risk that a borrower won’t
    pay back the lender as agreed. Where this occurs, the financial sector will be
    impaired in playing its role (i) to intermediate further funds, (ii) generate funds to
    sustain its operations. Since profitability is the guiding force to any operation of
    the bank, including credit extension their facilities should yield a certain level of
    profit to sustain its capital.
    The various types of credit risk faced by financial institutions may be categorized
    into, management risk, geographical risk, business risk, financial risk, and
    industrial risks. Under these are other factors such as:
    Increasing Interest rates
    High levels of NPLs exacerbate the risk-averse lending behavior of banks, limiting
    their ability to increase their interest income. This becomes a particular concern
    when earnings from interests on loans lack the potential to generate strong earnings
    to cover for the probable losses. The vulnerability of banks’ profitability to the rise
    and fall of interest rates is further worsened by the fact that pre-tax profitability is
    only 1% of average assets if trading gains are excluded.
    High operating expenses
    The high operating expenses contribute to the inability of the banking system to
    generate profits. On average, operating expenses have eaten up 89% of the
    operating income for the last five years. As of the third quarter of 2004, operating
    expenses have grown by 5% from the same period in 2003. This problem reflects
    the inefficiencies in the banking system that threatens its operating fundamentals.
    Corporate Governance Problems
    Corporate governance problems in the banking sector are evidenced by the
    prominence of a few bank auditors, absence of domestic credit rating agencies, and
    lack of proper disclosure and reporting of information, and compliance with
    international accounting standards. The presence of family and conglomerate
    ownership coupled with the lack of stringent regulations poses risks of distorting
    bank decisions to favor certain vested interests. In fact, some even see the lingering
    NPL problem as a reflection of lax corporate governance standards.
    It must be noted however, that efforts to strengthen corporate governance in banks
    have been initiated. On top of the existing corporate governance code set by the
    SEC, banks have started to institutionalize the framework for a corporate scorecard
    that aims to apply “peer pressure” in raising the standards in professional and
    ethical practice and improving the competencies of bank directors, audit
    committees, and risk management committees.

    Conclusion and Recommendations


    The recent upgrade by the CBN on the credit ratings of the bigger commercial
    banks in the country from ‘negative’ to ‘stable’ is a welcome development for the
    financial sector. Banks must still however, contend with their inherent problems.
    Banks have to clean up their balance sheets and find ways to best facilitate the
    absorption of losses involved in NPL sales. The key is for banks to manage the
    risks properly while still being able to serve the credit needs of the economy. Weak
    bank lending has undesirable consequences for the economy. If financing will be
    limited to only a few large corporations, this would negatively affect investment
    growth, thereby limiting output growth and employment. The following reforms
    are therefore necessary to ensure that the banking system is profitable, stable and is
    growing at a sustainable rate.
    Address NPL Problem
    Successful financial reform efforts in other countries usually involved an influx of
    investments in an NPL market and an accompanying prudential regulatory effort
    on the part of the government to ensure that banks will be rid of their bad loans.
    The success of Taiwan in lowering its NPLs was due to the creation of an investor-
    friendly environment which involved instituting a simple system for disposing of
    bad assets, protecting creditor rights, and lowering transaction costs. Thus, policies
    that aim to establish an attractive NPL market for investors will be most helpful to
    address the NPL problem of the finance sector. A common policy in other
    countries was to set a targeted NPL ratio that should be strictly met by the banks or
    to impose a higher ROE to promote diligence among banks to improve its
    profitability. The regulatory/supervisory efforts of the central banks and the
    Nigerian deposit insurance corporation should be articulated more on the undue
    interference from bad credit policies, political crises, undercapitalization and
    fraudulent practices of the insiders. These factors are the most critical factors
    inhibiting efficient performance of the Nigerian financial institutions and where
    they can be simultaneously arrested; the problem of bank failure will be put to a
    halt.
    This research will be written in 5 chapters which will deliberate on all that
    has been briefly discussed above. Chapter one will introduce the research as a
    whole dwelling on the definitions of key points, like Credit, financial system etc
    and the objectives of the study, background to the study, scope and problem
    statement of the study. Chapter two contains the literature review and its
    theoretical framework. Chapter three will contain background information on the
    Nigerian economy in relation to the financial institutions operations over a period
    of time. Chapter four of the research will contain the research methodology using
    the most appropriate model choices, empirical analysis with the implication of
    findings discussed in relation to the study. And lastly will be chapter five in which
    will be summary of findings and policy recommendations and will help solve the
    problem of credit operation in financial institutions in the country.

    References
    Odedokun, M.O (1998) Effectiveness of Selective Credit Policies
    Alternative Framework of Evaluation World Development Vol. 16 pp.120-122
    Kashyap, A.K. S.C. Stein (1997) The Role of Banks in Monetary Policy:
    Economic Perspectives FRB Chicago Sept. /Oct (3-18)
    Peek S., Rosengren E.S (1995) Bank Lending and Transmission of
    Monetary Policy” Conference Proceedings by Federal Reserve Babk of Boston
    pp.47-68
    Ogujiuba K.K, Ohuche F.K, Adenuga A.O, “Credit Availabilty to small and
    Meduim scale Enterprises in Nigeria: Importance of New Capital Base for Banks-
    Backgound and Issues, Working Paper, November 2004.
    International Monetary Fund. Global Financial Stability Report. “Market
    Developments and Issues”, April 2005.

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